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Better than the headlines – but caution is still advised

Andrea Quapp, Investment Director for Multi Asset Class Solutions (MACS) Continental Europe, advises investors to look through the impact of a flood of negative news flow, including the tragic events in the Middle East and Ukraine. While people are understandably unsettled, she believes they are also overestimating the impact on the macroeconomy.

01 November 2023

The financial markets are used to worry – and usually look beyond it into the future. The latest escalation in the Middle East, aside from oil, is also taking place outside the main economic arenas. The known political adversaries are rattling their sabres, but one may assume and not least hope that a conflagration will not break out due to the mediation efforts of many important states.

In recent months, equities have trended lower and yields on government bonds, which are typically considered safe, have climbed sharply in some cases. But this development appears to be coming to an end; the stock market correction seems to have been mainly due to profit taking after the previous rally. More recently, numerous monetary authorities have signalled that they have no interest in further tightening of financing conditions. As a result, government bond yields have fallen noticeably. The flight to safe havens and rising oil prices due to the Middle East conflict were rather moderate and only short-lived.

Asset allocation: A small step towards more security

Due to the recurring discussion about recession, weak earnings growth, stubbornly high inflation rates, the unpredictability of China and the aforementioned conflicts in the Middle East and Ukraine, we feel a slightly defensive positioning in asset allocation makes sense. However, the fact volatility has only increased slightly on stock markets to levels that are still normal for the market gives an indication that excessive reallocations are not indicated.

After a brief period of weakness, the dollar is now stabilising again. In the US, consumers are not running out of steam, as evidenced by strong retail sales. US citizens are in good financial health. The labour market is booming; wage increases are now higher than inflation. Many economists believe that the US will not even have to go through a mild recession. The tone of the US central bankers regarding further interest rate hikes has become much more moderate. In the eurozone, meanwhile, the economic data are still weaker than expected overall, but they are no longer deviating downwards as much as they did a few months ago.

The consequences of the "interest rate pause" on the bond markets

The taming of inflation and the likely peaking of policy rates is leading to a more relaxed situation in the interest rate markets. Thanks to higher rates, attractive and safe yields can be achieved in the main markets without investors having to switch to high yield and emerging market bonds or to the "safe haven" of government bonds. Because the volatility of interest rates has noticeably decreased thanks to the interest rate pause of the relevant central banks, the duration in bond portfolios can also be increased somewhat again, after short-dated bonds were favoured for a long time.

However, it is still apparent that many market participants lack experience. After decades of continuously falling yields and supposedly "easy" price gains, many have found it difficult since last autumn to recognise the new reality and to implement it appropriately in their portfolios.

Equity valuations have normalised

Global equity markets are showing amazing resilience. With the rapid increase in key interest rates, it looked as if the years-long dominance of equity securities over bonds would come to a lasting end. But after a year and a half of global stock markets oscillating around the peak – the Swiss blue-chip index SMI finished weaker than other major indices – almost everything seems to be back to normal. The once exaggerated valuations have largely normalised and the upcoming reporting season should provide some positive surprises, which is also due to many earnings revisions in the past few quarters. Recently frowned upon sectors such as banks, utilities and food producers could be convincing, in our view. Of course, even these cannot escape the economic environment – and a tightening of the geopolitical situation would leave its mark.

In recent months, the topic of artificial intelligence (AI) has driven the shares of large companies in the growth segment of technology to new highs. But the impact of AI on the economy is difficult to assess. Even companies from traditional segments could achieve significant efficiency gains with this technology, which would show up in corporate profits. The prospect of stagnating, and perhaps even slightly lower, key interest rates will support the equity markets in the coming months, in our opinion. However, investors' focus should be on corporate earnings forecasts and whether they will be met or even exceeded. The long-favoured dividend stocks have taken a back seat in view of the impact of high interest rates on the bond market.

Swiss specifics and alternative investments

Switzerland's special starting position prevents the local real estate "bubble" from running out of steam, as has been observed in the markets of other countries. High immigration and regulation, which increasingly hinders construction activity, ensure high demand and limited supply in the country; the vacancy rate remains just above 1%. Real estate remains an important asset class for investors, but we do not think investors should be adding to their weighting at present. In Switzerland, there is also a country-specific discussion on the "almost monopoly" in indirect real estate investments. Due to the takeover of Credit Suisse by UBS, the new "superbank" has a dominant influence in the area of real estate funds.

Other alternative investments – besides real estate – lack the potential to influence tactical allocation decisions. Only individual, low-correlation macro hedge funds with macro strategies focusing on equities and bonds currently offer a certain level of diversification. The revelations about Sam Bankman-Fried's FTX scam cast an unfavourable light on crypto investments. At the moment, therefore, digital assets lack the impetus for both upward and downward movement.

Important disclosures and information
The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio nor represent any recommendations by the portfolio managers nor a guarantee that objectives will be realized.

This material contains forward-looking statements relating to the objectives, opportunities, and the future performance of the U.S. market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.

Andrea Quapp

Investment Director, Head of GAM Investment Solutions
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